Charles Blair, DDS
John McGill, MBA, CPA, JD
During the past year, I have been contacted several times by a group promising huge tax deductions using a Section 419 retirement plan. I am told that since this plan is not covered by the regular retirement-plan rules, I can make large contributions for myself to fund a future severance benefit, while only minimal contributions are required on behalf of staff. This sounds too good to be true, and my accountant advises against it. What do you think?
Run - do not walk - away from this advice!
In Neonatology Associates, P.A. vs. Commissioner 115 TC 43 (7/31/00), several groups of doctors made contributions to separate plans formed under two purported Section 419 VEBA plans, crafted by insurance salesmen and marketed to professional small-business owners as a viable tax-planning device.
Each plan provided that the doctors would receive term-life insurance benefits. However, the premiums on the underlying insurance policy substantially exceeded the cost of the term-life insurance, with the excess being applied to convert - at the doctor's option - the term insurance into a universal life insurance policy with substantial cash value. As a result, after five years, the doctor could withdraw any earned amount or borrow against it with no out-of-pocket expense.
In this situation, the Tax Court found that the plans were not designed, marketed, purchased, or sold as a means to provide welfare benefits to the employees of the corporation, but, rather, were designed solely for the tax benefits provided to the owner-doctors. Accordingly, the Tax Court disallowed all of the deductions for contributions to the plan that exceeded the minimal costs of the group term-life insurance. Moreover, the disallowed contributions were taxed twice (once to the corporation and again as constructive dividends to the doctors). Finally, the judge slapped the doctors with substantial penalties for negligence and intentional disregard of the rules and regulations of the tax laws.
The IRS recently served notice that Section 419 plans now are "listed transactions." This requires the promoter to file with the IRS a listing of all such programs along with the individuals participating. The investment also must be disclosed on the doctor's tax return.
Despite what you have been told, these transactions are on the IRS' "hit list." You face a substantial likelihood of an IRS audit, possible disallowance, and imposition of penalties should you decide to participate.
A financial planner recently advised me to buy a variable life insurance policy with $500,000 of coverage, requiring a $5,000 annual premium. The cost of insurance is deducted from the premium, with the balance invested in a money market fund. Due to declining interest rates, the policy's expenses exceed the interest income. Thus, my cash value is decreasing. Am I getting ripped off?
Although there does not appear to be any fraudulent conduct on the part of your financial adviser, it is quite possible that this type of policy is not the best for you. Using after-tax funds to accumulate cash for retirement is very rarely necessary these days.
The 2001 Tax Act substantially increased doctors' ability to fund for retirement on a pretax (tax-de ductible) basis. Moreover, the funds within the plan grow tax-deferred, the same as a variable universal life policy, but without the significant fees and expenses. Your interests in retirement funding usually will be best served through utilizing other types of IRAs and retirement-plan accounts.
The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.
Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration.
McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($177 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.
